Liquidity Fragmentation: Is it Asia’s Turn to Go Next?
Fragmentation has evolved in the U.S. and Europe, but the diverse Asian markets are likely to forge their own course, as technological advances and regulatory developments make their impact felt around the region, argues Steve Grob, Strategy Director at Fidessa.
Fragmentation of liquidity has completely reshaped the equities trading landscape in the US and in Europe. It changed the roles of market participants forever by breaking the national monopolies of major exchanges and replacing them with a dazzling array of lit and dark venues. At the same time, it has also blurred the previously clear cut distinction between venues, brokers and buy-sides as each jostles for position in the new liquidity workflow. The next generation of winners and losers is now emerging – the trading equivalent of the“haves” and “have nots” – as different market players seek to embrace the challenge of fragmentation and turn it to their advantage.
This article looks at what may happen across Asian markets in terms of fragmentation. There are, of course, many differences between the trading environment across Asia and the more homogonous environments we see in Europe and, particularly, in the US. Top of the list is the fact there is nothing like the regulatory mandate for change in Asia as we have witnessed in the US and in Europe. Nevertheless, a number of isolated “bush fires”have already broken out in the region, and these raise the issue of whether fragmentation will really take hold and how it might spread. And, if it does, how will it be similar (or different) to our experiences in other parts of the globe?
RegNMS and its European cous
RegNMS and its European cousin MiFID were two pieces of legislation that introduced a concept of “best execution” for both retail and institutional investors aimed at providing greater transparency throughout the whole trading life-cycle. This was achieved by dismantling the national monopolies of the existing stock exchanges and fostering the creation of low cost alternative venues that focussed solely on providing markets for secondary trading in equities. Because these new venues were unencumbered by the other operations of stock exchanges (primary listings, trade reporting, supervision, etc.) they were able to operate on a much smaller cost base. These venues also invested in the latest matching technology which operated faster and at lower cost. The net result of this was that ECNs in the US and MTFs in Europe were able to aggressively compete for trading volumes and, in many cases, caught the incumbent exchanges napping. On top of this, they also introduced maker-taker pricing models which rewarded participants for posting passive liquidity and charged traders for removing or aggregating liquidity.
Many of these new venues were backed by the new Electronic Liquidity Providers (ELPs) such as Getco, Citadel, Optiver and Knight. These firms are able to use their technological prowess to benefit from tiny differences in prices and trading fees between the different venues. Such is their dominance that, according to the TABB Group, High Frequency Trading (HFT) of this sort now accounts for nearly 50% of US equities volume and over a third of the trading in Europe.
The large banks and brokers sought to leverage their own crossing networks against this backdrop too, whilst the alternative and primary market centres also jumped at the opportunity to introduce their own “dark pools” into the mix.
